Making Bad News Pay

David Tice has a reputation for analyzing anything that comes his way. Ask

15-year-old daughter Abby. When she was five, her father helped her set up a

lemonade business–after a lot of analysis. Abby set up her lemonade concession

on Saturdays along the bike trails. Little wonder that she ended up making more

pennies than most other kids in her neighborhood.

The analysis Tice gets paid for earns him far less adoration than he got for

his lemonade advice. Tice is a professional stock-market bear. He writes

scathing research reports, which he sells to institutional investors, detailing

why the stocks of some companies could be headed for a fall. He also runs a

mutual fund called the Prudent Bear that sells stocks short. While the typical

investor wants to buy low and sell high, short-sellers do the opposite,

borrowing stock and selling it at a high price and then buying it back cheap

after the price falls.

His research is getting more popular, too. His client list has increased 40%

in the last three years, to 200 people. He takes pride in being a reality check

on Wall Street analysts, who are coming under fire for producing overly positive

research to boost their investment-banking business. "I feel particularly

responsible about warning people that there’s a cliff down below, and Wall

Street will never say that," he says.

Gobbledygook

Despite the stock market’s decline over the past 18 months, he thinks there’s

still a cliff ahead. About 75% of his investments are short bets, he says. Among

favorite targets these days are top tech players, including Amazon.com, Yahoo!,

Dell Computers, and eBay. He thinks some, including Dell and eBay, are good

companies that are simply overvalued. For example, he says analysts have been

egging on investors to buy Dell stock at a lofty 35 times their estimate of 2003

earnings. He calls the estimates "gobbledygook" because a price war

among PC sellers will hurt profits. By contrast, he thinks Yahoo still needs to

prove it has a legitimate business beyond being an Internet portal dependent on

online advertising. Many continue to consider Yahoo a strong growth company, but

Tice calls its operating performance "horrific," with 2001 revenues

likely to be 35% below last year’s. "If it’s a growth company, how come

it’s more cyclical than General Motors?" he questions. Yahoo didn’t

return calls seeking comment.

Tice finds his targets by playing the role of a sleuth, going over balance

sheets, income statements, and cash-flow statements with a fine-toothed comb. He

looks for misleading numbers or bogus information that, once uncovered, will

cause a stock to tumble. His analysis is almost always the opposite of Wall

Street’s. But critics argue that Tice sometimes overreaches.

No question, the late 1990s were rough years for Tice. As the bull market

galloped ever higher, Prudent Bear was hit with negative returns of 34% and 23%

in 1998 and 1999. Tice, like many others, kept guessing that stocks were

overvalued only to see them rise higher. Many shorts closed shop, reducing the

field from 25 managers in 1990 to six at the end of the decade, according to

Harry Strunk, a Palm Beach investment consultant who tracks short-only managers.

Sanity Check

Whether Tice is right or wrong about a stock going down,

clients value his insights. Monica Graham, a partner at the New York hedge fund

Graham Partners, thinks Tice is one of the most talented analysts she has ever

worked with. "For me, he is a sanity check at a time when it’s easy to be

swept away by all the euphoria," she says.

Consider his research into Amazon.com. Tice wrote his first

negative report on the company in October, 1998, arguing that its business was

flawed because it hadn’t shown the ability to translate rising sales into

profits. The stock continued to soar in 1999. Finally, last year, Tice made

money shorting Amazon as its stock fell 80%.

He’s still not convinced of Amazon’s business. He blasts

the pro forma earnings reported by the e-tailer as "nonsense" that

suits the company more than investors. While the company also reports financial

results under standard accounting rules, it highlights pro forma earnings that

exclude many expenses. Tice also points out that Amazon’s growth in its core

business of books, music, and videos has slowed to a crawl, and it now

emphasizes its faster-growing consumer electronics business. He calls it a

classic case of "Don’t look over here, look over here." He also says

that CEO Jeff Bezos has sold 1.1 million shares in the last three months. Amazon

spokesman Bill Curry says that Bezos has sold only 2% of his holdings to

diversify his portfolio and still owns 32% of the company. He added that pro

forma earnings are widely accepted.

One short position that Tice has regularly lost money on is

America Online, now AOL Time Warner. In 1994, Tice released a report questioning

the validity of the business, especially in the face of increased competition.

"I miscalculated the power of the brand and the customer’s loyalty,"

says Tice, who has an AOL account himself. That doesn’t mean he has quit: Tice

still believes that AOL is overvalued. One reason is that Internet use may be

slowing. As evidence, he cites a study by researcher Telecommunications Reports

International Inc. that shows US households with Net access dipped for the first

time ever by 0.3%, to 68.5 million in the first quarter. Another reason is AOL’s

accounting. The company reported that free cash flow, which usually comes from

operations, was $651 in this year’s first quarter. Tice figures it was only

$70 million after the cash settlement of a lawsuit related to the sale of Six

Flags Theme Parks and several other one-time charges. AOL spokesman Ed Adler

says that its operations did generate $651 million and argues that, under

standard accounting rules, special charges such as the settlement do not need to

be counted as expenses in the quarter in which they occur.

While investors often rip Tice apart on online bulletin

boards, he says they’re barking up the wrong tree: "We protect investors

with our analysis. The bad guys are the brokers that were promoting the

outrageous valuations of those companies," he argues. Tice recently went to

Washington to make his point. On June 14, he testified before a Congressional

committee chaired by Representative Richard Baker that is looking into the

erosion in the so-called Chinese wall that has traditionally shielded analysts

from investment-banking interests. Tice testified he believes the conflict of

interest between analysts and investment bankers encouraged stock market

speculation and pushed capital toward the tech sector at the expense of other

industries.

Tice attributes his skepticism to his Missouri upbringing.

"It’s a show-me state where we aspire to be as fiercely independent as

Harry Truman," says Tice who, like Truman, was raised in Independence.

These could just be the days for Give ‘Em Hell David Tice.

By Pallavi Gogoi in BusinessWeek. Copyright 2001 by The McGraw-Hill Companies, Inc